Report of bipartisan commission of the chamber of commerce

By Cydney Posner

A bipartisan commission established by the Chamber of Commerce to consider ways to improve the regulation of the U.S. capital markets has just published its report.  An article pasted below from the WSJ discusses the report.

Below are the principal recommendations excerpted from the report:

• Reform and modernize the federal government’s regulatory approach to financial markets and market participants.

The Commission recommends four primary operational and organizational changes to the U.S. financial services regulatory structure:

• • The SEC should realign its organizational structure to improve its efficiency and mirror the contours of the current capital markets, for example, by folding the Office of Compliance Inspections and Examinations (OCIE) back into the operating divisions to facilitate consistent interpretations of applicable rules.
  • The SEC should place greater emphasis on ensuring consistent and uniform compliance with the Administrative Procedures Act (APA) when adopting new or significant changes in policy, particularly the Office of Chief Accountant in connection with significant changes in accounting policy.
  • The SEC should implement, and Congress should support with targeted legislation (e.g., an SEC examination privilege), an enhanced “prudential” regulatory role over the financial intermediaries it regulates.
  • Congress should enact legislation to establish an optional federal insurance charter.

• Give the Securities and Exchange Commission (SEC) the flexibility to address issues relating to the implementation of the Sarbanes-Oxley Act of 2002 (SOX) by making it part of the Securities Exchange Act of 1934.

SOX is perhaps the only part of the federal securities laws that is not fully subject to the SEC’s general powers to issue rules and exemptions for the implementation of these laws. This has led to questions about the nature and extent of the SEC’s authority in the complex process of implementing SOX and has limited the flexibility of the SEC in addressing related issues. The Commission believes that taking this step would provide greater certainty to the marketplace by ensuring that the SEC has the clear authority to issue rules on important aspects of SOX that will need to be fine-tuned from time to time to the realities of the capital markets. For example, the SEC could issue rules applying Section 404 of SOX on internal controls with appropriate variations for public companies of different sizes, and the SEC could issue partial exemptions for foreign registrants subject to comparable home-country requirements.

• Convince public companies to stop issuing earnings guidance or, alternatively, move away from quarterly earnings guidance with one earnings per share (EPS) number to annual guidance with a range of EPS numbers.

The Commission recommends that all public companies seriously consider the permanent elimination of quarterly guidance on earnings per share (EPS). Alternatively, the Commission recommends that public companies move from quarterly guidance with one EPS number to annual guidance with a range of EPS numbers. In either case, the Commission recommends that public companies promulgate additional information on their long-term business strategies as well as on any material developments between quarterly announcements of actual earnings. The Commission believes that there is too much focus on the short-term performance of U.S. companies. The pressure for businesses to “hit” their targets can be overwhelming and creates adverse incentives to forgo value-added investments in long-term projects. Although a few high-performing companies have stopped making quarterly earnings projections, many companies have stopped doing so only after they have missed their earnings targets. As a result, an announcement that a company will stop making quarterly earnings projections is often interpreted as a “negative signal” by the securities markets.

• Call on domestic and international policy-makers to seriously consider proposals by others to address the significant risks faced by the public audit profession from catastrophic litigation, as well as the Commission’s suggestion that national audit firms be allowed to raise capital from private shareholders other than audit partners.

The Commission recommends that Congress, government agencies, and market participants engage in serious discussion about proposals made by others–– including safe harbors or damage limits in specified circumstances––to address the risk of losing another large audit firm. At the same time, to facilitate interstate audit practices, the Commission recommends that Congress create the option of a federal charter for a limited number of large national audit firms. These national audit firms would be allowed to raise capital from shareholders other than audit partners (subject to resolving independence issues), which might allow more capital to flow into the major audit firms and may incent investors like private equity funds to create a new fifth global audit firm.

The viability of the audit function is threatened by a variety of factors, including (i) unrealistic expectations about the precision of financial statements, as well as the inherent limits on an auditor’s ability to detect collusive frauds; (ii) criminal indictment of audit firms (rather than responsible audit partners); (iii) catastrophic litigation claims in a market in which commercial insurance simply is not available to the firms in adequate amounts to cover such claims; and (iv) multijurisdictional regulation and enforcement activities that pose a barrier to interstate and global service. Thus, the Commission believes that it is critical that domestic and foreign policymakers immediately engage in proactive discussions to consider a wide range of proposals to address serious issues concerning the viability of the public company auditing profession.

Public companies, audit firms, the SEC, PCAOB, and other financial services regulators and policy-makers should take affirmative steps toward closing the “expectations gap”––that is, work to establish realistic public expectations about the degree of precision inherent in financial statements and constraints on those auditing these statements. In addition, the DOJ should revise the McNulty Memorandum to address the special considerations relating to the consequences of criminally indicting an audit firm (i.e., the overarching public policy concern that a criminal indictment of a Big Four firm would have severe consequences for public company clients of that firm and for the U.S. economy). Given the significant public policy ramifications in the event of a catastrophic loss of a large public company audit firm, the Commission calls on domestic and international market participants and policymakers to engage immediately in a serious evaluation and discussion of possible means to address this risk of catastrophic loss, including the recommendation regarding backup insurance sponsored by Group of Eight (G-8) governments or international financial organizations,

• Increase retirement savings plans by connecting all employers of 21 or more employees without any retirement plan to a financial institution that will offer a retirement arrangement to those employees.

The Commission recommends that Congress enact legislation establishing tax-favored savings accounts for employees of companies with 21 or more employees that do not sponsor a retirement savings plan of any type. The Commission believes that the use of automatic payroll deductions will encourage greater retirement savings by employees of companies that do not offer any type of retirement plan. Millions of full-time employees work for companies with 21 or more employees that do not offer any type of employer-sponsored retirement plan. Under this proposed legislation, employers with 21 or more employees would choose a qualifying financial institution to offer retirement accounts to their
employees. Such employers would collect employee contributions through payroll deductions and transmit those contributions to that financial institution. Employees would be permitted to opt out of these arrangements at any time.

Furthermore, under these arrangements, employers would be allowed, but not required, to make employer contributions or to match employee contributions. Employer costs and ongoing responsibilities would be minimal; for example, employer responsibilities would be limited to choosing the financial institutions, monitoring the continued soundness of that institution, and transmitting employee contributions in a timely manner. The recipient financial institution would have the remaining fiduciary obligations.

• Encourage employers to sponsor retirement plans and enhance the portability of retirement accounts through the introduction of a simpler, consolidated 401(k)-type program.

The Commission recommends that Congress consolidate the various types of defined contribution (DC) plans into one 401(x) program. By reducing the costs associated with the administration and design of various types of DC plans, the 401(x) program will encourage employers to sponsor DC plans. Moreover, the 401(x) program would enhance the portability of retirement plans for any employee who changes jobs. The Commission also makes a number of specific litigation reform-related recommendations designed to enhance the effectiveness of the U.S. legal system. For example, the Commission urges that the Department of Justice (DOJ) should not request waiver of attorney-client privilege and work-product protection from business organizations under the threat of indictment or other enforcement action. Specifically, the Commission believes that waiver should not be considered as a cooperation credit factor in the decision of whether to indict the organization. The Commission also contends that the DOJ should reassess the circumstances under which vicarious criminal liability for corporations is appropriate and should provide additional guidance to corporations on the proactive efforts they may undertake to avoid vicarious criminal liability. In addition, the Commission believes that the DOJ should not base charging decisions on whether a corporation advances counsel fees to its executives.

The Commission recommends that Congress enact legislation formally establishing a selective waiver that would permit a private party voluntarily to share privileged information or documents with the SEC, subject to a confidentiality agreement without waiving the privilege with respect to private litigants. The Commission supports the bright-line test adopted in the Second Circuit under which professional services firms (including audit firms) may be found primarily liable for securities fraud under SEC Rule 10b-5 only if they actually make a material misstatement or omission. In addition, the Commission supports the rejection by the Eighth Circuit of “scheme liability” under SEC Rule 10b-5. The Commission advocates the adoption of these two standards by all Circuits or the Supreme Court and recommends that the SEC actively support the adoption of these standards. The Commission recommends that the SEC clarify that amounts investors receive from an established Fair Fund should offset the amount that investors are awarded in damages as a result of private securities litigation covering substantially similar claims. Similarly, the SEC should consider amounts already awarded to a class in a settlement or case resolution when determining a Fair Fund payout to any investor on substantially similar claims.
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Panel Urges Steps
To Boost Allure
Of U.S. Markets
Restructuring of SEC,
End to Profit Guidance
Are Among Proposals
By KARA SCANNELL
March 12, 2007; Page A1

WASHINGTON -- Responding to a chorus of complaints that the U.S. is losing its edge to foreign markets, a panel set up by the nation's biggest business lobby recommends steps including structural changes at the Securities and Exchange Commission, the end of quarterly earnings guidance and a boost in the nation's retirement savings.

The panel, commissioned by the U.S. Chamber of Commerce, is scheduled to release its report here today, kicking off a week of debate about U.S. competitiveness. (Read the full report.)

Tomorrow, Treasury Secretary Henry Paulson plans to host a roundtable discussion including former Federal Reserve Chairman Alan Greenspan, former Treasury Secretary Robert Rubin, investor Warren Buffett and Jeffrey Immelt, the chief executive of General Electric Co. On Wednesday, the chamber's panel is slated to host a conference featuring two prominent Democratic lawmakers and SEC Chairman Christopher Cox.

Wall Street and its allies have been sounding alarms for several months that U.S. rules and enforcement practices -- some adopted in the wake of corporate scandals -- threaten the primacy of U.S. capital markets amid stiff competition from rivals in Europe and Asia. Mr. Paulson, a former Goldman Sachs Group Inc. CEO, has made the issue one of his priorities.

But some of the recent analysis has been criticized for confusing the interests of Wall Street firms with the overall economy, and some of its political force has been diluted by the continuing scandal over options backdating. Moreover, if adopted, some of the recent recommendations, including some proposed by the chamber's panel, could reduce protections for investors and scrutiny of financial firms.

Wall Street has blamed onerous regulations in the U.S. for driving many initial public offerings of stock to overseas markets, but others say these markets have simply become more competitive in recent years.

The chamber-backed report, produced by a bipartisan panel that began work in 2005, is an effort to identify politically palatable ways to boost competitiveness. As such, its proposals may stand a better chance of adoption than previous and more sweeping calls for change. Some public companies -- such as Berkshire Hathaway Inc. and Washington Post Co. -- already decline to issue quarterly earnings guidance. And the SEC, under Mr. Cox, is already studying the more flexible regulatory approach of its counterpart in Britain.

The latest report urges policy makers to heed some recommendations of two previous studies -- one from a blue-ribbon committee led by Harvard University law professor Hal Scott and another commissioned by New York Sen. Charles Schumer and New York City Mayor Michael Bloomberg.

But unlike some of the earlier studies, the commission's report makes six fairly narrow recommendations that it says could be implemented within a year. Some of the recommendations would require congressional action, but others could be acted on by regulators or corporate executives.

The six recommendations are: changing the SEC's structure and approach to regulation; giving the agency more authority to exempt certain companies from adhering to the Sarbanes-Oxley corporate-reform law; promoting international discussion to prevent the type of litigation that led to the 2002 collapse of Arthur Andersen, one of the nation's biggest auditing firms; eliminating quarterly earnings estimates; making retirement savings accounts more easily available to workers; and making those accounts more portable when workers change jobs.

"Those six are relatively new, important and doable," said Robert Pozen, chairman of MFS Investment Management and a member of the commission.

The panel urged CEOs to stop giving quarterly earnings guidance, a move it says will divert attention from short-term results and provide more room for long-term thinking. The panel cited a study that showed more than half of the 400 CEOs polled said they would delay starting a new project to meet a profit target.

In part to boost the flow of funds to U.S. markets, the panel also recommended requiring all but the smallest companies that don't offer their workers retirement plans to arrange for their workers to invest through payroll deductions with a designated financial institution.

It also proposed consolidating various types of defined contribution retirement plans, such as 401(k)s, into one program to make them cheaper to process and easier for workers to take with them if they changed jobs.

The panel also called for reorganizing the SEC so that it more closely "mirrors" the nation's capital markets. The SEC currently has a division of market regulation that oversees broker-dealers and exchanges. The agency's investment-management division oversees investment companies and advisers, so there is some overlap between the two divisions.

The report also proposes creating three new divisions -- one to oversee market professionals, another for markets, exchanges and self-regulatory organizations, and a third for securities products, such as derivatives and mutual funds.

In addition, the chamber's panel recommends shuttering the SEC's inspections division, which examines brokerage firms and conducts broad market investigations, and melding its function into the other divisions. It says the advantage of such a structure would be more efficient and consistent guidance to the markets. The report says that could be further enhanced by more frequent and informal communication between the SEC staff and the securities industry.

The panel also recommended the SEC's office of international affairs be upgraded to a division, allowing it to expand its staff and raise its profile.

It isn't clear how Mr. Cox, a Republican, and the four other SEC commissioners will react to all of the recommendations. They have each acknowledged the global picture has changed, but agreeing on how to adapt might be more difficult. Though Mr. Cox meets regularly with British regulators to study their rules and enforcement regime, he has promised he won't allow the U.S. to forgo high standards, which he says are the best means of attracting investors to the U.S.

Democrats and Republicans have already conceded that at least one aspect of the Sarbanes-Oxley law is too burdensome: a rule that requires companies to review their own systems for ensuring accurate financial reports and then to have them tested by outside auditors.

While many groups have called for scaling back that requirement, which the SEC is doing, the chamber's panel urges Congress to make the Sarbanes-Oxley law part of the Securities Exchange Act of 1934. That would give the SEC the ability to exempt some constituents, such as foreign firms or small business, from the rule.

The commission also recommends that Congress create the option of a federal charter for a limited number of large auditing firms, and allow those firms to raise money from outside investors, including private equity. The commission says that might increase the capital available for the audit firms, which could lead to the emergence of a fifth national accounting firm.

Since Arthur Andersen collapsed in 2002 after being indicted in the Enron scandal, U.S. companies have been left with just four major auditing firms. Though some argue that cautious auditing is a good thing, many businesses complain that Sarbanes-Oxley, Andersen's indictment and the risks of private lawsuits have made auditors too conservative.

To address the litigation risk, the panel recommends the Group of Eight industrial nations sponsor backup insurance for the auditing profession and limit the ability to sue auditors in some circumstances if certain actions were performed in good faith.